UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-34635

POSTROCK ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

Delaware		27-0981065
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)

210 Park Avenue, Suite 2750, Oklahoma City, OK 73102
(Address of principal executive offices) (Zip Code)

(405) 600-7704
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ (Do not check if a smaller reporting company)		Smaller reporting company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of August 2, 2010, there were 8,053,008 shares of common stock of PostRock Energy Corporation outstanding.

 

 

POSTROCK ENERGY CORPORATION
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2010

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements			F-1
Condensed Consolidated Balance Sheets			F-1
Condensed Consolidated Statements of Operations			F-2
Condensed Consolidated Statements of Cash Flows			F-3
Condensed Consolidated Statement of Equity			F-4
Notes to Condensed Consolidated Financial Statements			F-5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			1
Item 3. Quantitative and Qualitative Disclosures About Market Risk			12
Item 4. Controls and Procedures			13
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			16
Item 1A. Risk Factors			16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			16
Item 3. Defaults Upon Senior Securities			16
Item 5. Other Information			16
Item 6. Exhibits			17
SIGNATURES			19
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I — FINANCIAL INFORMATION

Item 1.		Financial Statements

POSTROCK ENERGY CORPORATION AND SUBSIDIARIES

						(Predecessor)
		June 30, 2010				December 31, 2009
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	19,579			$	20,884
Restricted cash			565				718
Accounts receivable — trade, net			10,425				13,707
Other receivables			676				2,269
Other current assets			6,391				8,141
Inventory			7,375				9,702
Current derivative financial instrument assets			23,722				10,624
Total current assets			68,733				66,045
Oil and gas properties under full cost method of accounting, net			44,848				40,478
Pipeline assets, net			139,016				136,017
Other property and equipment, net			18,688				19,433
Other assets, net			2,407				2,727
Long-term derivative financial instrument assets			32,855				18,955
Total assets		$	306,547			$	283,655
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable		$	13,876			$	10,852
Revenue payable			4,792				5,895
Accrued expenses			11,304				11,417
Current portion of notes payable			305,191				310,015
Current derivative financial instrument liabilities			1,676				1,447
Total current liabilities			336,839				339,626
Long-term derivative financial instrument liabilities			6,406				8,569
Other liabilities			6,834				6,552
Notes payable			16,254				19,295
Commitments and contingencies
Equity:
Preferred stock of Predecessor, $0.001 par value; authorized shares — 50,000,000; none issued and outstanding							—
Common stock of Predecessor, $0.001 par value; authorized shares — 200,000,000; issued —32,160,121; outstanding —31,981,317							33
Preferred stock, $0.01 par value; authorized shares — 5,000,000; none issued and outstanding			—
Common stock, $0.01 par value; authorized shares — 40,000,000; issued and outstanding —8,053,008			80
Additional paid-in capital			368,346				299,010
Treasury stock, at cost							(7	)
Accumulated deficit			(428,212	)			(447,413	)
Total stockholders’ deficit before non-controlling interests			(59,786	)			(148,377	)
Non-controlling interests							57,990
Total equity			(59,786	)			(90,387	)
Total liabilities and equity		$	306,547			$	283,655

The accompanying notes are an integral part of these condensed consolidated financial statements.

POSTROCK ENERGY CORPORATION AND SUBSIDIARIES

						(Predecessor)								(Predecessor)
		Three Months				Three Months												Six Months
		Ended June				Ended June				March 6, 2010 to				January 1, 2010				Ended June
		30, 2010				30, 2009				June 30, 2010				to March 5, 2010				30, 2009
Revenue:
Oil and gas sales		$	20,120			$	16,107			$	28,591			$	18,659			$	38,382
Gas pipeline revenue			3,706				7,586				5,063				2,825				15,389
Total revenues			23,826				23,693				33,654				21,484				53,771
Costs and expenses:
Oil and gas production			7,024				7,274				9,529				5,266				14,960
Pipeline operating			6,645				6,861				8,895				4,489				14,021
General and administrative			7,960				10,486				11,114				5,735				18,368
Depreciation, depletion and amortization			4,905				9,086				6,008				4,164				25,206
Impairment of oil and gas properties			—				—				—				—				102,902
Recovery of misappropropriated funds			—				(3,397	)			—				—				(3,397	)
Total costs and expenses			26,534				30,310				35,546				19,654				172,060
Operating income (loss)			(2,708	)			(6,617	)			(1,892	)			1,830				(118,289	)
Other income (expense):
Gain (loss) from derivative financial instruments			(605	)			(17,138	)			17,968				25,246				22,326
Other income (expense), net			51				83				(230	)			(4	)			139
Interest expense, net			(6,325	)			(6,858	)			(8,423	)			(5,336	)			(13,746	)
Total other income (expense)			(6,879	)			(23,913	)			9,315				19,906				8,719
Income (loss) before income taxes and non-controlling interests			(9,587	)			(30,530	)			7,423				21,736				(109,570	)
Income tax expense			—				—				—				—				—
Net income (loss)			(9,587	)			(30,530	)			7,423				21,736				(109,570	)
Net (income) loss attributable to non-controlling interest			—				12,511				—				(9,958	)			40,165
Net income (loss) attributable to controlling interest		$	(9,587	)		$	(18,019	)		$	7,423			$	11,778			$	(69,405	)
Net income (loss) per common share:
Basic		$	(1.19	)		$	(0.57	)		$	0.92			$	0.37			$	(2.18	)
Diluted		$	(1.19	)		$	(0.57	)		$	0.91			$	0.36			$	(2.18	)
Weighted average shares outstanding:
Basic			8,049				31,868				8,047				32,137				31,799
Diluted			8,049				31,868				8,116				32,614				31,799

The accompanying notes are an integral part of these condensed consolidated financial statements.

POSTROCK ENERGY CORPORATION AND SUBSIDIARIES

						(Predecessor)
										Six Months
		March 6, 2010 to				January 1, 2010				Ended June
		June 30, 2010				to March 5, 2010				30, 2009
Cash flows from operating activities:
Net income (loss)		$	7,423			$	21,736			$	(109,570	)
Adjustments to reconcile net income (loss) to cash provided by operations:
Depreciation, depletion and amortization			6,008				4,164				25,206
Stock-based compensation			634				808				819
Impairment of oil and gas properties			—				—				102,902
Amortization of deferred loan costs			1,558				2,094				2,097
Change in fair value of derivative financial instruments			(7,359	)			(21,573	)			41,154
Loss (gain) on disposal of property and equipment			140				—				—
Non-cash portion of recovery of misappropriated funds			—				—				(977	)
Other non-cash changes to items affecting net income			111				—				—
Change in assets and liabilities:
Accounts receivable			3,519				(237	)			1,322
Other receivables			579				1,014				2,336
Other current assets			(2,305	)			466				386
Other assets			(3	)			2				116
Accounts payable			646				(83	)			(16,152	)
Revenue payable			(946	)			(157	)			480
Accrued expenses			1,710				983				1,817
Other long-term liabilities			(9	)			—				(1	)
Other			—				—				(57	)
Cash flows from operating activities			11,706				9,217				51,878
Cash flows from investing activities:
Restricted cash			154				(1	)			(201	)
Proceeds from sale of oil and gas properties			101				—				8,730
Equipment, development, leasehold and pipeline			(9,944	)			(2,282	)			(5,256	)
Cash flows from investing activities			(9,689	)			(2,283	)			3,273
Cash flows from financing activities:
Proceeds from bank borrowings			—				—				1,430
Repayments of bank borrowings			(13,215	)			(41	)			(9,662	)
Proceeds from revolver			2,100				900				—
Repayments of revolver note			—				—				(17,902	)
Refinancing costs			—				—				(389	)
Cash flows from financing activities			(11,115	)			859				(26,523	)
Net increase (decrease) in cash			(9,098	)			7,793				28,628
Cash and cash equivalents beginning of period			28,677				20,884				13,785
Cash and cash equivalents end of period		$	19,579			$	28,677			$	42,413

The accompanying notes are an integral part of these condensed consolidated financial statements.

POSTROCK ENERGY CORPORATION

																						Total
																						Stockholders’
		Common								Additional												Deficit Before
		Shares				Common				Paid-in				Treasury				Accumulated				Non-controlling				Non-controlling				Total
		Issued				Stock				Capital				Stock				Deficit				Interests				Interests				Equity
Predecessor:
Balance, December 31, 2009			32,160,121			$	33			$	299,010			$	(7	)		$	(447,413	)		$	(148,377	)		$	57,990			$	(90,387	)
Stock based compensation			(1,687	)			—				210				—				—				210				598				808
Net income			—				—				—				—				11,778				11,778				9,958				21,736
Balance, March 5, 2010			32,158,434			$	33			$	299,220			$	(7	)		$	(435,635	)		$	(136,389	)		$	68,546			$	(67,843	)
Successor:
Balance, March 6, 2010			—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Issuance to Predecessor shareholders upon recombination			1,847,458				18				299,228				—				(435,635	)			(136,389	)			—				(136,389	)
Issuance to Predecessor noncontrolling interests upon recombination			6,191,516				62				68,484				—				—				68,546				—				68,546
Stock based compensation			14,034				—				634				—				—				634				—				634
Net income			—				—				—				—				7,423				7,423				—				7,423
Balance, June 30, 2010			8,053,008			$	80			$	368,346			$	—			$	(428,212	)		$	(59,786	)		$	—			$	(59,786	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

POSTROCK ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2010
(Unaudited)

Note 1 — Basis of Presentation

     PostRock Energy Corporation (“PostRock” or “Successor”) is a Delaware corporation formed on July 1, 2009 for the purpose of effecting the recombination of Quest Resource Corporation (now named PostRock Energy Services Corporation) (“QRCP”), Quest Energy Partners, L.P. (now named PostRock MidContinent Production, LLC) (“QELP”) and Quest Midstream Partners, L.P. (now named PostRock Midstream, LLC) (“QMLP”). On July 2, 2009, PostRock, QRCP, QELP, QMLP and other parties thereto entered into a merger agreement pursuant to which QRCP, QELP and QMLP would recombine. The recombination was effected by forming a new publicly traded corporation, subsequently named PostRock, that, through a series of mergers and entity conversions, wholly owns all three entities. The recombination was completed on March 5, 2010. Since QRCP was the parent company which consolidated both QELP and QMLP prior to the recombination, the recombination was a transaction between equity interest holders within a consolidated entity rather than a business combination. The transaction was therefore accounted for on a historical cost basis. Since PostRock did not own any assets prior to the consummation of the recombination, the purpose of these condensed consolidated financial statements is to present the historical consolidated financial position and results of operations, cash flows and changes in equity of the predecessor entities (collectively referred to as “Predecessor”) prior to the recombination and to present such information for PostRock subsequent to the recombination. Unless the context requires otherwise, references to “we,” “us,” “our” or the “Company” are intended to mean and include the consolidated businesses and operations of our Predecessor for dates prior to March 6, 2010 and to the consolidated businesses and operations of PostRock and its subsidiaries for dates on or subsequent to March 6, 2010.

     The Company is an integrated independent energy company involved in the acquisition, development, gathering, transportation, exploration, and production of oil and natural gas. Its principal operations and producing properties are located in the Cherokee Basin of southeastern Kansas and northeastern Oklahoma and the Appalachian Basin in West Virginia and New York. The Company’s Appalachian Basin operations are primarily focused on the development of the Marcellus Shale. Its Cherokee Basin operations are currently focused on developing coal bed methane (“CBM”) gas production, which is served by a gas gathering pipeline network owned by the Company. The Company also owns an interstate natural gas transmission pipeline.

     The (a) condensed consolidated balance sheet as of December 31, 2009, which has been derived from audited financial statements, and (b) the unaudited interim condensed consolidated financial statements have been prepared by PostRock and the Predecessor pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), and reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods, on a basis consistent with the annual audited consolidated financial statements. All such adjustments are of a normal recurring nature. Certain information, accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the summary of significant accounting policies and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”).

     The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The operating results for the interim periods are not necessarily indicative of the results to be expected for the full year.

Going Concern

     The accompanying condensed consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business, though such an assumption may not be true. We have incurred significant losses from 2003 through 2009, mainly attributable to operations, the impairment of our assets, legal restructurings, financings, the legal and operational structure that existed prior to recombination, expenditures resulting from the investigation related to the misappropriation of funds by our former chief executive officer and our recent recombination activities. While we successfully negotiated amendments to our various credit facilities allowing us to accomplish the recombination, our current debt obligations as of June 30, 2010 were $305.2 million, of which $6.8 million was paid in July 2010. A payment due on July 11, 2010 under the QRCP credit facility of $20.5 million, which includes accrued interest and fees, was extended by our lender to October 9, 2010. We recently remediated a borrowing base deficiency of $13.6 million on our QELP credit facility using available funds and as a result, our cash balance has decreased to approximately $14.6 million as of August 2, 2010. In addition to prepayments arising from any borrowing base deficiency, QELP may also be required to make additional prepayments arising from the excess cash flow provision (as defined) under its credit agreement. We are actively pursuing the refinancing of our credit facilities, which could include the issuance of a significant amount of equity capital. There can be no assurance that we will be successful in these efforts or that we will have sufficient funds to pay these amounts when they come due, which raises substantial doubt as to our ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Recent Accounting Pronouncements and Recently Adopted Accounting Pronouncements

     In June 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Codification (“FASB ASC”) 105 Generally Accepted Accounting Principles, which establishes FASB ASC as the sole source of authoritative GAAP. Pursuant to the provisions of FASB ASC 105, the Company is currently disclosing updated references to GAAP in its financial statements. The adoption of this standard did not have a material impact on our consolidated financial statements.

     In January 2010, the FASB released Accounting Standards Update (“ASU”) 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. The update requires reporting entities to provide information about movements of assets among Levels 1 and 2 of the three-tier fair value hierarchy established under FASB ASC 820. The update also requires separate presentation (on a gross basis rather than as one net number) about purchases, sales, issuances, and settlements within the reconciliation of activity in Level 3 fair value measurements. The guidance is effective for any fiscal period beginning after December 15, 2009 except for the requirement to separately disclose purchases, sales, issuances, and settlements, which will be effective for any fiscal period beginning after December 15, 2010. The Company adopted the provisions of this update relating to disclosure on movement of assets among Levels 1 and 2 beginning with the quarter ended March 31, 2010. Other than additional disclosure required by the update, there was no material impact on our financial statements.

     In February 2010, the FASB released ASU 2010-09, Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements which removed some contradictions between the requirements of GAAP and the SEC’s filing rules. As a result, public companies will no longer have to disclose the date of their financial statements in both issued and revised financial statements. The amendments became effective upon issuance of the update and the Company adopted the provisions of this update beginning with the quarter ended March 31, 2010 with no material impact on its financial statements.

Note 2 — Long-Term Debt

     The following is a summary of our long-term debt as of the dates indicated (in thousands):

						(Predecessor)
		June 30,				December 31,
		2010				2009
Borrowings under bank senior credit facilities:
QRCP:
Term Loan		$	32,118			$	30,108
Revolving Line of Credit			7,300				4,300
Promissory Notes			1,334				1,250
QELP:
Quest Cherokee Credit Agreement			131,800				145,000
Second Lien Loan Agreement			30,118				29,821
QMLP:
Credit Agreement			118,728				118,728
Notes payable to banks and finance companies			47				103
Total debt			321,445				329,310
Less current maturities included in current liabilities			305,191				310,015
Total long-term debt		$	16,254			$	19,295

     The terms of our credit facilities are described within Item 8. Financial Statement and Supplementary Data in the 2009 Form 10-K. Upon closing of the recombination, the maturities of QELP’s and QMLP’s debt agreements were extended to March 31, 2011. During the first six months of 2010, $3.0 million was borrowed on QRCP’s revolving line of credit, the outstanding amounts under QRCP’s term loan and promissory notes were increased by a total of $2.1 million from the accrual of interest and $13.2 million was repaid on the Quest Cherokee Credit Agreement. On June 11, 2010 the borrowing base on the Quest Cherokee Credit Agreement was reduced to $125 million. QELP eliminated the borrowing base deficiency of $13.6 million using available cash in two equal installments of $6.8 million made in June and July 2010.

     On July 11, 2010, we obtained an amendment to our PostRock Energy Services Corporation Second Amended and Restated Credit Agreement (the “QRCP Credit Agreement”). As indicated in the table above, this agreement consists of a term loan, a revolving line of credit and promissory notes. Under the terms of the amendment, the maturity date and the date to fulfill the conditions of the QRCP Credit Agreement loans that were scheduled to mature on July 11, 2010, were extended to October 9, 2010. The amendment effectively extended a $20.5 million payment due on July 11, 2010 to October 9, 2010. The other terms of the QRCP Credit Agreement, including the January 12, 2012 maturity date of the term loan, were unchanged and no amendment fee was paid.

     Based on our operating results for the six months ended June 30, 2010 we were not in compliance with the interest coverage and total leverage ratio covenants of our QMLP credit agreement. In August 2010, the required lenders under the QMLP credit agreement agreed to waive these financial covenant events of default until September 15, 2010.

Note 3 — Derivative Financial Instruments

     We are exposed to commodity price risk, and management believes it prudent to periodically reduce our exposure to cash-flow variability resulting from this volatility. Accordingly, we enter into certain derivative financial instruments in order to manage exposure to commodity price risk inherent in our oil and gas production operations. Specifically, we may utilize futures, swaps and options. Futures contracts and commodity swap agreements are used to fix the price of expected future oil and gas sales at major industry trading locations, such as Henry Hub, Louisiana for gas and Cushing, Oklahoma for oil. Basis swaps are used to fix or float the price differential between the price of gas at Henry Hub and various other market locations. Options are used to fix a floor and a ceiling price (collar) for expected future oil and gas sales. Derivative financial instruments are also used to

manage commodity price risk inherent in customer pricing requirements and to fix margins on the future sale of natural gas.

     Settlements of any exchange-traded contracts are guaranteed by the New York Mercantile Exchange (NYMEX) or the Intercontinental Exchange and are subject to nominal credit risk. Over-the-counter traded swaps, options and physical delivery contracts expose us to credit risk to the extent the counterparty is unable to satisfy its settlement commitment. We monitor the creditworthiness of each counterparty and assess the impact, if any, on fair value. In addition, we routinely exercise our contractual right to net realized gains against realized losses when settling with our swap and option counterparties. A material portion of our derivative positions are with BP Corporation North America Inc, a subsidiary of BP Plc (“BP”) of which we have a net asset position. As a result of the explosion and oil spill in the Gulf of Mexico in April 2010, BP is faced with unprecedented liabilities for the ecological and economic effects of the spill. Its credit rating has been downgraded by the major rating agencies and may be subject to further downgrades if costs associated with the oil spill continue to escalate. We have incorporated the increase in BP’s credit risk into the fair value estimates of our contracts with BP by increasing the risk premium component of the discount rate on the resulting expected cash flows.

     We account for our derivative financial instruments in accordance with FASB ASC 815 Derivatives and Hedging. FASB ASC 815 requires that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. FASB ASC Topic 815 requires that changes in the derivative’s fair value be recognized currently in earnings unless specific hedge accounting criteria are met, or exemptions for normal purchases and normal sales (“NPNS”) as permitted by FASB ASC 815 exist. We do not designate our derivative financial instruments as hedging instruments for financial accounting purposes, and, as a result, we recognize the change in the respective instruments’ fair value currently in earnings. In accordance with FASB ASC 815, the table below outlines the classification of our derivative financial instruments on our condensed consolidated balance sheets and their financial impact in our condensed consolidated statements of operations as of and for the periods indicated (in thousands):

Fair Value of Derivative Financial Instruments

								(Predecessor)
				June 30,				December 31,
Derivative Financial Instruments		Balance Sheet location		2010				2009
Commodity contracts		Current derivative financial instrument asset		$	23,722			$	10,624
Commodity contracts		Long-term derivative financial instrument asset			32,855				18,955
Commodity contracts		Current derivative financial instrument liability			(1,676	)			(1,447	)
Commodity contracts		Long-term derivative financial instrument liability			(6,406	)			(8,569	)
				$	48,495			$	19,563

     Settlements in the normal course of maturities of our derivative financial instrument contracts result in cash receipts from or cash disbursement to our derivative contract counterparties and are, therefore, realized gains or losses. Changes in the fair value of our derivative financial instrument contracts are included in income currently with a corresponding increase or decrease in the balance sheet fair value amounts. Gains and losses associated with derivative financial instruments related to oil and gas production were as follows for the periods indicated (in thousands):

														(Predecessor)
		Three Months				Three Months				March 6, 2010				January 1,				Six Months
		Ended June				Ended June				to June 30,				2010 to March				Ended June
		30, 2010				30, 2009				2010				5, 2010				30, 2009
Realized gains (losses)		$	7,475			$	46,646			$	10,609			$	3,673			$	63,480
Unrealized gains (losses)			(8,080	)			(63,784	)			7,359				21,573				(41,154	)
Total		$	(605	)		$	(17,138	)		$	17,968			$	25,246			$	22,326

     The following table summarizes the estimated volumes, fixed prices and fair values attributable to oil and gas derivative contracts as of June 30, 2010:

		Remainder of				Year Ending December 31,
		2010				2011				2012				2013				Total
Natural Gas Swaps:
Contract volumes (Mmbtu)			8,197,178				13,550,302				11,000,004				9,000,003				41,747,487
Weighted-average fixed price per Mmbtu		$	6.05			$	6.80			$	7.13			$	7.28			$	6.84
Fair value, net		$	12,510			$	20,149			$	14,195			$	9,567			$	56,421
Basis Swaps:
Contract volumes (Mmbtu)			1,896,282				8,549,998				9,000,000				9,000,003				28,446,283
Weighted-average fixed price per Mmbtu		$	(0.66	)		$	(0.67	)		$	(0.70	)		$	(0.71	)		$	(0.69	)
Fair value, net		$	(475	)		$	(2,589	)		$	(2,642	)		$	(2,377	)		$	(8,083	)
Crude Oil Swaps:
Contract volumes (Bbl)			15,000				—				—				—				15,000
Weighted-average fixed price per Bbl		$	87.50			$	—			$	—			$	—			$	87.50
Fair value, net		$	157			$	—			$	—			$	—			$	157
Total fair value, net		$	12,192			$	17,560			$	11,553			$	7,190			$	48,495

     The following table summarizes the estimated volumes, fixed prices and fair values attributable to gas derivative contracts of the Company’s predecessor as of December 31, 2009:

		Year Ending December 31,
		2010				2011				2012				Thereafter				Total
		(in thousands, except volumes and per unit data)
Natural Gas Swaps:
Contract volumes (Mmbtu)			16,129,060				13,550,302				11,000,004				9,000,003				49,679,369
Weighted-average fixed price per Mmbtu		$	6.26			$	6.80			$	7.13			$	7.28			$	6.78
Fair value, net		$	10,424			$	7,530			$	6,662			$	4,763			$	29,379
Natural Gas Basis Swaps:
Contract volumes (Mmbtu):			3,630,000				8,549,998				9,000,000				9,000,003				30,180,001
Weighted-average fixed price per Mmbtu		$	(0.63	)		$	(0.67	)		$	(0.70	)		$	(0.71	)		$	(0.69	)
Fair value, net		$	(1,402	)		$	(2,973	)		$	(2,879	)		$	(2,717	)		$	(9,971	)
Crude Oil Swaps:
Contract volumes (Bbl)			30,000				—				—				—				30,000
Weighted-average fixed price per Bbl		$	87.50			$	—			$	—			$	—			$	87.50
Fair value, net		$	155			$	—			$	—			$	—			$	155
Total fair value, net		$	9,177			$	4,557			$	3,783			$	2,046			$	19,563

Note 4 — Fair Value Measurements

     Our financial instruments include commodity derivatives, debt, cash, receivables and payables. The carrying value of our debt approximates fair value due to the variable nature of the interest rates. The carrying amount of cash, receivables and payables approximates fair value because of the short-term nature of those instruments.

     Effective January 1, 2009, we adopted FASB ASC 820 Fair Value Measurements and Disclosures, which applies to our nonfinancial assets and liabilities for which we disclose or recognize at fair value on a nonrecurring

basis, such as asset retirement obligations and other assets and liabilities. Fair value is the exit price that we would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date.

     FASB ASC 820 also establishes a hierarchy that prioritizes the inputs used to measure fair value. The three levels of the fair value hierarchy are as follows:

•

Level 1 — Quoted prices available in active markets for identical assets or liabilities as of the reporting date.

•

Level 2 — Pricing inputs other than quoted prices in active markets included in Level 1 which are either directly or indirectly observable as of the reporting date. Level 2 consists primarily of non-exchange traded commodity derivatives.

•

Level 3 — Pricing inputs include significant inputs that are generally less observable from objective sources.

     We classify assets and liabilities within the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement of each individual asset and liability taken as a whole. Certain of our derivatives are classified as Level 3 because observable market data is not available for all of the time periods for which we have derivative instruments. As observable market data becomes available for all of the time periods, these derivative positions will be reclassified as Level 2.

     ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements requires reporting entities to provide information about movements of assets among Levels 1 and 2 of the three-tier fair value hierarchy established under FASB ASC 820. There were no movements between Levels 1 and 2 for the three month or six month periods ending June 30, 2010 and 2009.

     The following table sets forth, by level within the fair value hierarchy, our assets and liabilities that were measured at fair value on a recurring basis as of the dates indicated (in thousands):

		Level				Level				Level				Total Net Fair
		1				2				3				Value
June 30, 2010
Commodity derivatives — assets		$	—			$	37,533			$	19,044			$	56,577
Commodity derivatives — liabilities		$	—			$	—			$	(8,082	)		$	(8,082	)
Total		$	—			$	37,533			$	10,962			$	48,495
December 31, 2009 (Predecessor)
Commodity derivatives — assets		$	—			$	18,033			$	11,546			$	29,579
Commodity derivatives — liabilities		$	—			$	—			$	(10,016	)		$	(10,016	)
Total		$	—			$	18,033			$	1,530			$	19,563

     Risk management assets and liabilities in the table above represent the current fair value of all open derivative positions, excluding those derivatives designated as NPNS. We classify all of these derivative instruments as “Derivative financial instrument assets” or “Derivative financial instrument liabilities” in our condensed consolidated balance sheets.

     In order to determine the fair value of amounts presented above, we utilize various factors, including market data and assumptions that market participants would use in pricing assets or liabilities as well as assumptions about the risks inherent in the inputs to the valuation technique. These factors include not only the credit standing of the counterparties involved and the impact of credit enhancements (such as cash deposits, letters of credit and parental guarantees), but also the impact of our nonperformance risk on our liabilities. We utilize observable market data for credit default swaps to assess the impact of non-performance credit risk when evaluating our assets from counterparties.

     In certain instances, we may utilize internal models to measure the fair value of our derivative instruments. Generally, we use similar models to value similar instruments. Valuation models utilize various inputs which include quoted prices for similar assets or

liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, other observable inputs for the assets or liabilities, and market-corroborated inputs, which are inputs derived principally from or corroborated by observable market data by correlation or other means.

     The following table sets forth a reconciliation of changes in the fair value of risk management assets and liabilities classified as Level 3 in the fair value hierarchy (in thousands):

						Predecessor
		March 6, 2010 to				January 1, 2010 to				Six Months Ended
		June 30, 2010				March 5, 2010				June 30, 2009
Balance at beginning of period		$	5,455			$	1,530			$	60,947
Realized and unrealized gains included in earnings			13,713				7,254				19,695
Purchases, sales, issuances, and settlements			(8,206	)			(3,329	)			(56,791	)
Transfers into and out of Level 3			—				—				—
Balance at end of period		$	10,962			$	5,455			$	23,851

Note 5 — Asset Retirement Obligations

     The following table reflects the changes to our asset retirement liability for the period indicated (in thousands):

						(Predecessor)
		March 6, 2010				January 1, 2010
		to June 30, 2010				to March 5, 2010
Asset retirement obligations at beginning of period		$	6,648			$	6,552
Liabilities incurred			3				—
Liabilities settled			(10	)			(1	)
Accretion			193				97
Revisions in estimated cash flows			—				—
Asset retirement obligations at end of period		$	6,834			$	6,648

Note 6 — Equity and Earnings per Share

     Share-Based Payments — Immediately prior to the recombination, there were 1,155,327 restricted shares of QRCP, 945,593 phantom units of QELP and 732,784 restricted units of QMLP that were unvested. In the recombination, 118,816 restricted shares of QRCP, 7,500 phantom units of QELP and 67,838 restricted units of QMLP were subject to immediate vesting immediately prior to the closing and, at closing, these awards converted to 36,416 shares of PostRock common stock. PostRock’s predecessor and the predecessor’s consolidated subsidiaries recognized $0.4 million of compensation expense related to the accelerated vesting discussed above. All remaining unvested awards were converted to 595,923 PostRock restricted share awards. In addition, 670,000 of QRCP stock options converted to 38,525 PostRock stock options upon effectiveness of the recombination. For the three months ended June 30, 2010, total share-based compensation related to stock awards and options of PostRock or its predecessor and consolidated subsidiaries of its predecessor was $0.6 million compared to $0.3 million for the three months ended June 30, 2009. The share based compensation expense was $1.4 million and $0.8 million for the six month period ended June 30, 2010 and 2009, respectively. Share-based compensation is included in general and administrative expense on our statements of operations. The granting of future stock awards and options to our employees subsequent to the recombination is governed by PostRock’s 2010 Long-Term Incentive Plan (the “LTIP”). As of June 30, 2010 there were 795,964 shares available under the LTIP for future stock awards and options. Subsequent to the recombination, during 2010, 54,036 shares of PostRock stock were granted to officers and directors of the Company while 91,991 restricted shares and 18,975 stocks options were forfeited as a result of employee turnover. Total share-based compensation to be recognized on unvested stock awards and options as of June 30, 2010 is $1.9 million over a weighted average period of 1.57 years.

     Noncontrolling interests — A rollforward of the noncontrolling interests of our Predecessor’s investments in QELP and QMLP for the periods indicated is as follows (in thousands):

		(Predecessor)
						Three Months				Six Months
		January 1, 2010				Ended June				Ended June
		to March 5, 2010 (1)				30, 2009				30, 2009
QELP
Beginning of period		$	15,350			$	29,378			$	58,666
Net income (loss) attributable to non-controlling interest			10,365				(13,247	)			(42,568	)
Stock compensation expense related to QELP unit-based awards			167				—				33
End of period		$	25,882			$	16,131			$	16,131
QMLP
Beginning of period		$	42,640			$	147,698			$	145,870
Net income (loss) attributable to non-controlling interest			(407	)			736				2,403
Stock compensation expense related to QMLP unit-based awards			431				177				338
End of period		$	42,664			$	148,611			$	148,611
Total non-controlling interest at end of period		$	68,546			$	164,742			$	164,742

     Income/(Loss) per Share — A reconciliation of the numerator and denominator used in the basic and diluted per share calculations for the periods indicated is as follows (dollars in thousands, except share and per share amounts):

						(Predecessor)								(Predecessor)
		Three Months				Three Months				March 6, 2010				January 1,				Six Months
		Ended June				Ended June				to June 30,				2010 to March				Ended June
		30, 2010				30, 2009				2010				5, 2010				30, 2009
Net income (loss) attributable to common stockholders		$	(9,587	)		$	(18,019	)		$	7,423			$	11,778			$	(69,405	)
Denominator:
Common shares			8,048,998				31,867,857				8,046,771				32,016,327				31,798,546
Unvested share-based awards participating (1)			—				—				—				121,121				—
Denominator for basic earnings per share			8,048,998				31,867,857				8,046,771				32,137,448				31,798,546
Effect of potentially dilutive securities:
Unvested share-based awards non-participating			—				—				68,465				450,751				—
Stock options			—				—				316				26,154				—
Denominator for diluted earnings per share			8,048,998				31,867,857				8,115,552				32,614,353				31,798,546
Basic earnings per share		$	(1.19	)		$	(0.57	)		$	0.92			$	0.37			$	(2.18	)
Diluted earnings per share		$	(1.19	)		$	(0.57	)		$	0.91			$	0.36			$	(2.18	)
Securities excluded from earnings per share calculation:
Unvested share-based awards participating (1)(2)			—				302,049				—				—				302,049
Antidilutive stock options			19,550				700,000				19,550				570,000				700,000

Note 7 — Impairment of Oil and Gas Properties

     At the end of each quarterly period, the unamortized cost of oil and natural gas properties, net of related deferred income taxes, is limited to the full cost ceiling, computed as the sum of the estimated future net revenues from our proved reserves using twelve-month average prices discounted at 10%, and adjusted for related income tax effects (ceiling test). Prior to December 31, 2009, the present value was calculated using spot market prices at the balance sheet date. In the event our capitalized costs exceed the ceiling limitation at the end of the reporting date, we subsequently evaluate the limitation based on price changes that occur after the balance sheet date to assess impairment as currently permitted by Staff Accounting Bulletin Topic 12—Oil and Gas Producing Activities. Under full cost accounting rules, any ceiling test write-downs of oil and natural gas properties may not be reversed in subsequent periods. Since we do not designate our derivative financial instruments as hedges, we are not allowed to use the impacts of the derivative financial instruments in our ceiling test computation. As a result, decreases in commodity prices which contribute to ceiling test write-downs may be offset by mark-to-market gains which are not reflected in our ceiling test results.

     Under the present full cost accounting rules, we are required to compute the after-tax present value of our proved oil and natural gas properties using twelve-month average prices for oil and natural gas at our balance sheet date. The base for our spot prices for natural gas is Henry Hub and for oil is Cushing, Oklahoma. The Predecessor had previously recognized a ceiling test impairment of $102.9 million during the first quarter of 2009 while no impairment has resulted in 2010. Natural gas, which is sold at other natural gas marketing hubs where we conduct operations, is subject to prices which reflect variables that can increase or decrease spot natural gas prices at these hubs such as market demand, transportation costs and quality of the natural gas being sold. Those differences are referred to as the basis differentials. In the past, basis differentials resulted in natural gas prices for our Cherokee Basin production which were lower than Henry Hub, except in Appalachia, where we have typically received a premium to Henry Hub. We may face further ceiling test write-downs in future periods, depending on the level of commodity prices, drilling results and well performance.

     The calculation of the ceiling test is based upon estimates of proved reserves. There are numerous uncertainties inherent in estimating quantities of proved reserves, in projecting the future rates of production and in the timing of development activities. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing, production and changes in economics related to the properties subsequent to the date of the estimate may justify revision of such estimate. Accordingly, reserve estimates are often different from the quantities of oil and natural gas that are ultimately recovered.

Note 8 — Income Taxes

     The effective income tax rate of the Predecessor for the three months and six months ended June 30, 2009, for the three months ended June 30, 2010 and for the periods from January 1, 2010 through March 5, 2010 and from March 6, 2010 through June 30, 2010 is less than the federal statutory rate primarily due to the effect of changes in the valuation allowance on the net deferred tax asset.

     On March 5, 2010, the Company completed the recombination which resulted in an ownership change for purposes of Internal Revenue Code Section 382 and significantly restricts the Company’s ability to utilize its otherwise available net operating loss (“NOL”) carryforwards. Accordingly, the Company has reduced its gross deferred tax assets for the NOL carryforwards that it does not believe will be utilized because of the restrictions imposed by Section 382, and has also reversed the associated valuation allowance recorded by the Company in prior periods against such NOLs.

     The Company has recorded no provision for income taxes for the pre-tax earnings for the three months and six months ended June 30, 2009, for the three months ended June 30, 2010 and for the period from March 6, 2010 through June 30, 2010 as it believes that such earnings can be offset by its remaining unutilized NOLs from prior periods. The Company will continue to record a full valuation allowance against the remaining net deferred tax assets because it does not believe that it is more likely than not that the future tax benefits will be realized.

Note 9 — Commitments and Contingencies

Litigation

     We are subject, from time to time, to certain legal proceedings and claims in the ordinary course of conducting our business.

Federal Securities Class Actions

Michael Friedman, individually and on behalf of all others similarly situated v. Quest Energy Partners LP, Quest Energy GP LLC, Quest Resource Corporation, Jerry Cash, and David E. Grose , Case No. 08-cv-936-M, U.S. District Court for the Western District of Oklahoma, filed September 5, 2008

James Jents, individually and on behalf of all others similarly situated v. Quest Resource Corporation, Jerry Cash, David E. Grose, and John Garrison, Case No. 08-cv-968-M, U.S. District Court for the Western District of Oklahoma, filed September 12, 2008

J. Braxton Kyzer and Bapui Rao, individually and on behalf of all others similarly situated v. Quest Energy Partners LP, Quest Energy GP LLC, Quest Resource Corporation and David E. Grose , Case No. 08-cv-1066-M, U.S. District Court for the Western District of Oklahoma, filed October 6, 2008

Paul Rosen, individually and on behalf of all others similarly situated v. Quest Energy Partners LP, Quest Energy GP LLC, Quest Resource Corporation, Jerry Cash, and David E. Grose , Case No. 08-cv-978-M, U.S. District Court for the Western District of Oklahoma, filed September 17, 2008

     Four putative class action complaints were filed in the United States District Court for the Western District of Oklahoma naming QRCP, QELP and Quest Energy GP, LLC, the general partner of the predecessor of QELP (“QEGP”) and certain of their then current and former officers and directors as defendants. The complaints were filed by certain stockholders on behalf of themselves and other stockholders who purchased QRCP common stock between May 2, 2005 and August 25, 2008 and QELP common units between November 7, 2007 and August 25, 2008. The complaints assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Rule 10b-5 promulgated thereunder, and Sections 11 and 15 of the Securities Act of 1933. The complaints allege that the defendants violated the federal securities laws by issuing false and misleading statements and/or concealing material facts concerning certain unauthorized transfers of funds from subsidiaries of QRCP to entities controlled by QRCP’s former chief executive officer, Mr. Jerry D. Cash. The complaints also allege that, as a result of these actions, QRCP’s stock price and the unit price of QELP was artificially inflated during the class period. On December 29, 2008, the court consolidated these complaints as Michael Friedman, individually and on behalf of all others similarly situated v. Quest Energy Partners LP, Quest Energy GP LLC, Quest Resource Corporation, Jerry Cash, and David E. Grose , Case No. 08-cv-936-M, in the Western District of Oklahoma. On September 24, 2009, the court appointed lead plaintiffs for each of the QRCP class and the QELP class. On November 4, 2009, the court granted the lead plaintiffs’ unopposed request to file separate consolidated amended complaints. The court ordered that all pleadings and filings for the QELP class be filed under Friedman v. Quest Energy Partners, LP, et al. , case no. CIV-08-936-M, and all pleadings and filings for the QRCP class be filed under Jents v. Quest Resource Corporation, et al., case no. CIV-08-968-M. The QELP lead plaintiffs filed a consolidated complaint on November 10, 2009. The consolidated complaint names as additional defendants David C. Lawler, Gary Pittman, Mark Stansberry, Murrell Hall, McIntosh & Co. PLLP, and Eide Bailly LLP. The QRCP lead plaintiffs filed a consolidated complaint on December 7, 2009, which names Murrell, Hall, McIntosh & Co. PLLP, Eide Bailly LLP, and various former QRCP directors as additional defendants. Mediation was held among the parties on February 2 and April 2, 2010. An agreement to settle all of the federal securities lawsuits, both individual and class action, as well as the federal derivative suits, has been reached in principle. The settlement is subject to court approval. On July 9, 2010, a stipulation of settlement was filed in the consolidated action. On July 22, 2010 a motion for preliminary approval of the settlement was filed with the court. On July 23, 2010, an objection to the motion was filed by the Enders derivative plaintiff. However, Enders has now agreed to withdraw that objection. We have agreed to contribute $1.0 million to the proposed settlement of the lawsuits and recorded an additional $0.4 million for anticipated additional settlement costs. While we have recorded an accrual

for these amounts in the first quarter of 2010, there can be no assurance that final approval of the settlement will be granted by the court or that the final settlement amount will equal the amount of the accrual.

  Federal Individual Securities Litigation

Bristol Capital Advisors v. Quest Resource Corporation, Inc., Jerry Cash, David E. Grose, and John Garrison , Case No. CIV-09-932, U.S. District Court for the Western District of Oklahoma, filed August 24, 2009

     On August 24, 2009, a complaint was filed in the United States District Court for the Western District of Oklahoma naming QRCP and certain then current and former officers and directors as defendants. The complaint was filed by an individual stockholder of QRCP. The complaint asserts claims under Sections 10(b) and 20(a) of the Exchange Act. The complaint alleges that the defendants violated the federal securities laws by issuing false and misleading statements and/or concealing material information concerning unauthorized transfers from subsidiaries of QRCP to entities controlled by QRCP’s former chief executive officer, Mr. Jerry D. Cash. The complaint also alleges that QRCP issued false and misleading statements and or/concealed material information concerning a misappropriation by its former chief financial officer, Mr. David E. Grose, of $1 million in company funds and receipt of unauthorized kickbacks of approximately $850,000 from a company vendor. The complaint also alleges that, as a result of these actions, QRCP’s stock price was artificially inflated when the plaintiff purchased their shares of QRCP common stock. As discussed above, an agreement to settle has been reached in principle. The settlement is subject to court approval and there can be no assurance that final approval of the settlement will be granted by the court.

J. Steven Emerson, Emerson Partners, J. Steven Emerson Roth IRA, J. Steven Emerson IRA RO II, and Emerson Family Foundation v. Quest Resource Corporation, Inc., Quest Energy Partners L.P., Jerry Cash, David E. Grose, and John Garrison, Case No. 5:09-cv-1226-M, U.S. District Court for the Western District of Oklahoma, filed November 3, 2009

     On November 3, 2009, a complaint was filed in the United States District Court for the Western District of Oklahoma naming QRCP, QELP, and certain then current and former officers and directors as defendants. The complaint was filed by individual shareholders of QRCP stock and individual purchasers of QELP common units. The complaint asserts claims under Sections 10(b) and 20(a) of the Exchange Act. The complaint alleges that the defendants violated the federal securities laws by issuing false and misleading statements and/or concealing material information concerning unauthorized transfers from subsidiaries of QRCP to entities controlled by QRCP’s former chief executive officer, Mr. Jerry D. Cash. The complaint also alleges that QRCP and QELP issued false and misleading statements and or/concealed material information concerning a misappropriation by its former chief financial officer, Mr. David E. Grose, of $1 million in company funds and receipt of unauthorized kickbacks of approximately $850,000 from a company vendor. The complaint also alleges that, as a result of these actions, the price of QRCP stock and QELP common units was artificially inflated when the plaintiffs purchased QRCP stock and QELP common units. The plaintiffs seek $10 million in damages. As discussed above, an agreement to settle has been reached in principle. The settlement is subject to court approval and there can be no assurance that final approval of the settlement will be granted by the court

  Federal Derivative Cases

James Stephens, derivatively on behalf of nominal defendant Quest Resource Corporation v. William H. Damon III, Jerry Cash, David Lawler, David E. Grose, James B. Kite Jr., John C. Garrison and Jon H. Rateau, Case No. 08-cv-1025-M, U.S. District Court for the Western District of Oklahoma, filed September 25, 2008

     On September 25, 2008, a complaint was filed in the United States District Court for the Western District of Oklahoma, purportedly on QRCP’s behalf, which named certain of QRCP’s then current and former officers and directors as defendants. The factual allegations mirror those in the purported class actions described above, and the complaint asserts claims for breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment. The complaint seeks disgorgement, costs, expenses, and equitable and/or injunctive relief. On October 16, 2008, the court stayed this case pending the court’s ruling on any motions to dismiss the class action claims. Proceedings in this matter are currently stayed. As discussed above, an agreement to settle has been

reached in principle. The settlement is subject to court approval and there can be no assurance that final approval of the settlement will be granted by the court.

William Dean Enders, derivatively on behalf of nominal defendant Quest Energy Partners, L.P. v. Jerry D. Cash, David E. Grose, David C. Lawler, Gary Pittman, Mark Stansberry, J. Philip McCormick, Douglas Brent Mueller, Mid Continent Pipe & Equipment, LLC, Reliable Pipe & Equipment, LLC, RHB Global, LLC, RHB, Inc., Rodger H. Brooks, Murrell, Hall, McIntosh & Co. PLLP, and Eide Bailly LLP, Case No. CIV-09-752-F, U.S. District Court for the Western District of Oklahoma, filed July 17, 2009

     On July 17, 2009, a complaint was filed in the United States District Court for the Western District of Oklahoma, purportedly on QELP’s behalf, which named certain of its then current and former officers and directors, external auditors and vendors. The factual allegations relate to, among other things, the transfers and lack of effective internal controls. The complaint asserts claims for breach of fiduciary duty, waste of corporate assets, unjust enrichment, conversion, disgorgement under the Sarbanes-Oxley Act of 2002, and aiding and abetting breaches of fiduciary duties against the individual defendants and vendors and professional negligence and breach of contract against the external auditors. The complaint seeks monetary damages, disgorgement, costs and expenses and equitable and/or injunctive relief. It also seeks QELP to take all necessary actions to reform and improve its corporate governance and internal procedures. On September 8, 2009, the case was transferred to Judge Miles-LaGrange, who is presiding over the other federal cases, and the case number was changed to CIV-09-752-M. All proceedings in this matter are currently stayed. As discussed above, an agreement to settle has been reached in principle. The settlement is subject to court approval and there can be no assurance that final approval of the settlement will be granted by the court.

  State Court Derivative Cases

Tim Bodeker, derivatively on behalf of nominal defendant Quest Resource Corporation v. Jerry Cash, David E. Grose, Bob G. Alexander, David C. Lawler, James B. Kite, John C. Garrison, Jon H. Rateau and William H. Damon III , Case No. CJ-2008-9042, District Court of Oklahoma County, State of Oklahoma, filed October 8, 2008

William H. Jacobson, derivatively on behalf of nominal defendant Quest Resource Corporation v. Jerry Cash, David E. Grose, David C. Lawler, James B. Kite, Jon H. Rateau, Bob G. Alexander, William H. Damon III, John C. Garrison, Murrell, Hall, McIntosh & Co., LLP, and Eide Bailly, LLP, Case No. CJ-2008-9657, District Court of Oklahoma County, State of Oklahoma, filed October 27, 2008

Amy Wulfert, derivatively on behalf of nominal defendant Quest Resource Corporation, v. Jerry D. Cash, David C. Lawler, Jon C. Garrison, John H. Rateau, James B. Kite Jr., William H. Damon III, David E. Grose, N. Malone Mitchell III, and Bryan Simmons , Case No. CJ-2008-9042 — consolidated December 30, 2008, District Court of Oklahoma County, State of Oklahoma (Original Case No. CJ-2008-9624, filed October 24, 2008)

     The factual allegations in these petitions mirror those in the purported class actions discussed above. All three petitions assert claims for breach of fiduciary duty, abuse of control, gross mismanagement, and unjust enrichment. The Jacobson petition also asserts claims against the two auditing firms named in that suit for professional negligence and aiding and abetting the director defendants’ breaches of fiduciary duties. The Wulfert petition also asserts a claim against Mr. Bryan Simmons for aiding and abetting Messrs. Cash’s and Grose’s breaches of fiduciary duties. The petitions seek damages, costs, expenses, and equitable relief. On March 26, 2009, the court consolidated these actions as In re Quest Resource Corporation Shareholder Derivative Litigation , Case No. CJ-2008-9042. Under the court’s order, the defendants need not respond to the individual petitions. The action is stayed by agreement of the parties until the motions to dismiss in the pending federal securities class action litigation are decided. Parties are in discussions to resolve all the suits. If the action cannot be amicably resolved, the defendants intend to file a motion to dismiss.

  Royalty Owner Class Action

Hugo Spieker, et al. v. Quest Cherokee, LLC, Case No. 07-1225-MLB, U.S. District Court for the District of Kansas, filed August 6, 2007

     Quest Cherokee, a wholly-owned subsidiary of QELP, was named as a defendant in a putative class action lawsuit filed by several royalty owners in the U.S. District Court for the District of Kansas. The case was filed by the named plaintiffs on behalf of a putative class consisting of all Quest Cherokee’s royalty and overriding royalty owners in the Kansas portion of the Cherokee Basin. Plaintiffs contend that Quest Cherokee failed to properly make royalty payments to them and the putative class by, among other things, paying royalties based on reduced volumes instead of volumes measured at the wellheads, by allocating expenses in excess of the actual costs of the services represented, by allocating production costs to the royalty owners, by improperly allocating marketing costs to the royalty owners, and by making the royalty payments after the statutorily proscribed time for doing so without providing the required interest. Quest Cherokee has answered the complaint and denied plaintiffs’ claims. On July 21, 2009, the court granted plaintiffs’ motion to compel production of Quest Cherokee’s electronically stored information, or ESI, and directed the parties to decide upon a timeframe for producing Quest Cherokee’s ESI. Quest Cherokee’s most recent offer, for which it has recorded an accrual, was for $1.0 million to resolve claims for all past royalty payments, and a proposed formula for resolving the issue of future gathering/compression rates. A stay of discovery has been continued to provide the parties with time to participate in a mediation. On July 22, 2010 the parties participated in a mediation. A second mediation is now set for August 23, 2010.

  Litigation Related to Oil and Gas Leases

Billy Bob Willis, et al. v. Quest Resource Corporation, et al., Case No. CJ-09-063, District Court of Nowata County, State of Oklahoma, filed April 28, 2009

Larry Reitz, et al. v. Quest Resource Corporation, et al., Case No. CJ-09-076, District Court of Nowata County, State of Oklahoma, filed May 22, 2009

     Quest Resource Corporation, et al. have been named in the above-referenced lawsuits, which have been consolidated to proceed as a single action. Plaintiffs are 56 individual royalty owners who allege that the defendants have wrongfully deducted costs from the royalties of plaintiffs and have engaged in self-dealing contracts resulting in less than market price for the gas production. Plaintiffs pray for unspecified actual and punitive damages. The defendants have filed a motion to dismiss certain tort claims, but no ruling has yet been issued by the court. Limited pretrial discovery has occurred. No court deadlines have been set. The parties are in discussions to schedule a mediation in September 2010. QRCP intends to defend vigorously against the plaintiffs’ claims.

Contractual Commitments

     We have numerous contractual commitments in the ordinary course of business, debt service requirements and operating lease commitments. Our commitments as of December 31, 2009, are disclosed within Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Contractual Obligations in our 2009 Form 10-K. In February 2010, we extended an investment advisory service agreement that would have otherwise expired for an additional five months in exchange for monthly payments of $50,000. We also entered into an equity financing advisory agreement in February 2010 that would require a minimum payment of $750,000 payable on June 30, 2010. That payment has been deferred pending the outcome of our recent activities to secure such financing. Other than the preceding contracts, there are no other material changes to our commitments since December 31, 2009.

Note 10 — Operating Segments

     In our Quarterly Report on Form 10-Q for the quarter ended June 30, 2009, we overstated the intercompany transportation revenue related to our natural gas pipeline segment and the corresponding intercompany transportation expense related to our oil and gas production segment by $2.1 million and $4.3 million for the three month and for the six month periods ended June 30, 2009. As a result, our measure of segment profitability related to the natural gas pipeline segment was overstated by $2.1 and $4.3 million while segment profitability related to the oil and natural gas production segment were understated by the same amounts for the corresponding periods. The error did not affect consolidated total revenues or net income for the affected periods. The disclosure below reflects correction of the misstatement discussed above. Operating segment data for the periods indicated is as follows (in thousands):

										Other and
		Oil and Gas				Natural Gas				Intersegment
		Production				Pipelines				Eliminations				Total
Three months ended June 30, 2010:
Total revenues		$	20,120			$	11,491			$	(7,785	)		$	23,826
Inter-segment revenues			—				(7,785	)			7,785				—
Third-party revenues		$	20,120			$	3,706			$	—			$	23,826
Segment operating profit (loss)		$	2,005			$	3,247			$	—			$	5,252
Three months ended June 30, 2009 (Predecessor):
Total revenues		$	16,107			$	17,539			$	(9,953	)		$	23,693
Inter-segment revenues			—				(9,953	)			9,953				—
Third-party revenues		$	16,107			$	7,586			$	—			$	23,693
Segment operating profit (loss)		$	(6,156	)		$	6,628			$	—			$	472
March 6, 2010 to June 30, 2010:
Total revenues		$	28,591			$	15,599			$	(10,536	)		$	33,654
Inter-segment revenues			—				(10,536	)			10,536				—
Third-party revenues		$	28,591			$	5,063			$	—			$	33,654
Segment operating profit (loss)		$	4,615			$	4,607			$	—			$	9,222
January 1, 2010 to March 5, 2010 (Predecessor):
Total revenues		$	18,659			$	7,788			$	(4,963	)		$	21,484
Inter-segment revenues			—				(4,963	)			4,963				—
Third-party revenues		$	18,659			$	2,825			$	—			$	21,484
Segment operating profit		$	5,314			$	2,251			$	—			$	7,565
Six months ended June 30, 2009 (Predecessor):
Total revenues		$	38,382			$	35,625			$	(20,236	)		$	53,771
Inter-segment revenues			—				(20,236	)			20,236				—
Third-party revenues		$	38,382			$	15,389			$	—			$	53,771
Segment operating profit (loss)		$	(116,904	)		$	13,586			$	—			$	(103,318	)
Identifiable assets:
June 30, 2010		$	152,079			$	154,468			$	—			$	306,547
December 31, 2009 (Predecessor)		$	128,548			$	155,107			$	—			$	283,655

     The following table reconciles segment operating profits reported above to income (loss) before income taxes and non-controlling interests (in thousands):

														Predecessor
		Three Months				Three Months								January 1,				Six Months
		Ended June 30,				Ended June 30,				March 6, 2010 to				2010 to				Ended June 30,
		2010				2009				June 30, 2010				March 5, 2010				2009
Segment operating profit (loss) (1)		$	5,252			$	472			$	9,222			$	7,565			$	(103,318	)
General and administrative expenses			(7,960	)			(10,486	)			(11,114	)			(5,735	)			(18,368	)
Recovery of misappropriated funds, net			—				3,397				—				—				3,397
Gain (loss) from derivative financial instruments			(605	)			(17,138	)			17,968				25,246				22,326
Interest expense, net			(6,325	)			(6,858	)			(8,423	)			(5,336	)			(13,746	)
Other income (expense), net			51				83				(230	)			(4	)			139
Income (loss) before income taxes and noncontrolling interests		$	(9,587	)		$	(30,530	)		$	7,423			$	21,736			$	(109,570	)

Note 11 — Subsequent Events

     We evaluated our activity after June 30, 2010 until the date of issuance, for recognized and unrecognized subsequent events not discussed elsewhere in these footnotes and determined there were none.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking statements

     Various statements in this report, including those that express a belief, expectation, or intention, as well as those that are not statements of historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include those regarding projections and estimates concerning the timing and success of specific projects; financial position; business strategy; budgets; amount, nature and timing of capital expenditures; drilling of wells and construction of pipeline infrastructure; acquisition and development of oil and natural gas properties and related pipeline infrastructure; timing and amount of future production of oil and natural gas; operating costs and other expenses; estimated future net revenues from oil and natural gas reserves and the present value thereof; cash flow and anticipated liquidity; funding of our capital expenditures; ability to meet our debt service obligations; and other plans and objectives for future operations.

     When we use the words “believe,” “intend,” “expect,” “may,” “will,” “should,” “anticipate,” “could,” “estimate,” “plan,” “predict,” “project,” or their negatives, or other similar expressions, the statements which include those words are usually forward-looking statements. When we describe strategy that involves risks or uncertainties, we are making forward-looking statements. The factors impacting these risks and uncertainties include, but are not limited to:

	•		current weak economic conditions;
	•		our current financial condition and liquidity constraints;
	•		volatility of oil and natural gas prices;
	•		benefits or effects of the recombination;
	•		increases in the cost of drilling, completion and gas gathering or other costs of developing and producing our reserves;
	•		our restrictive debt covenants;
	•		access to capital, including debt and equity markets;
	•		results of our hedging activities;
	•		drilling, operational and environmental risks; and
	•		regulatory changes and litigation risks.

     You should consider carefully the statements in Part I, Item 1A. “Risk Factors” of our 2009 Form 10-K and other sections of this Quarterly Report on Form 10-Q, which describe factors that could cause our actual results to differ from those set forth in the forward-looking statements.

     We have based these forward-looking statements on our current expectations and assumptions about future events. The forward-looking statements in this report speak only as of the date of this report; we disclaim any obligation to update these statements unless required by securities law, and we caution you not to rely on them unduly. Readers are urged to carefully review and consider the various disclosures made by us in our reports filed with the SEC, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operation and cash flows. If one or more of these risks or uncertainties materialize, or if the underlying assumptions prove incorrect, our actual results may vary materially from those expected or projected.